Chapter 15 - multiplier can be considerably smaller than...

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Money Creation CHAPTER SUMMARY A single bank creates money (adds to the money supply) whenever a loan is made. Whenever a loan is repaid the money supply contracts. This is because the amount of M2 as assets to the non-banking public changes. A single bank can only loan out the amount of funds it has as excess reserves. A change in required reserves can change excess reserves and therefore the loan-creating ability of a single bank. Although a single bank is limited in its money creating ability dollar for dollar with its excess reserves, an entire banking system can create money, or add to the money supply, by a multiple of its excess reserves. This is because the reserves lost by one bank are gained by another bank. The multiple change in the money supply, given some change in the banking system's excess reserves, can be calculated by multiplying the money multiplier (equal to the reciprocal of the required reserve ratio) by the change in excess reserves. The real world money
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Unformatted text preview: multiplier can be considerably smaller than the simple multiplier. Monetary policy is the Federal Reserve's use of open market operations, changes in the discount rate, and changes in the required reserve ratio to change the money supply. If the Fed buys government securities on the open market, reduces the discount rate, or decreases the required reserve ratio this will increase the money supply. The opposite is also true. There are limitations associated with the effectiveness of monetary policy as there are with the use of fiscal policy. Some of those limitations include the fact that the money multiplier can change, there is the presence of non-bank financial institutions which affect the money supply that are outside the control of the Fed, and the difficulty in choosing which measure of the money supply to change....
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